Page 20 - Griffenomics

GRIFFENOMICS ISSUE 1
20
HEDGE FUNDS
FACT: THE CHURCH OF ENGLAND HAS PLANS TO EXPAND ITS HEDGE FUND INVESTMENT USING MONEY FROM ITS ENDOWMENTS
Hedge fund is a term that I found
to be used frequently in the me-
dia, usually with negative con-
notations, such as the Bernie Madoff
scandal of late 2008, but I never really
understood what they were or how they
actually made money. So, I looked into it,
and this is what I found.
In order to determine what a hedge
fund is, we must first know what a fund
is, and why people invest in them. A fund
pools money from individuals or firms,
which is then invested. Having a pooled
investment is beneficial because not only
does it mean that you take advantage of
the fund manager’s specialist knowledge,
it alsomeans that by pooling yourmoney,
the fund has access to investments that
would not be available to you as an indi-
vidual investor. Also, the risk is spread
between the large numbers of investors,
so the investment does not depend heav-
ily on any one individual or company.
A hedge fund is eƒectively an invest-
ment partnership between the fundman-
ager and the investors in the hedge fund,
also called limited partners. The limited
partners provide the money for the fund
manager to manage according to the
fund’s strategy, which is essentially how
the fund manager decides to invest the
hedge fund’s money. As hedge funds are
not currently regulated by the US Secu-
rities and Exchange Commission (SEC),
or another international equivalent, they
are able to invest in a wider range of se-
curities than other types of funds, such
as mutual funds. However, they do still
invest in traditional securities. A securi-
ty, in financial terms, is a tradable asset
of any kind, such as stocks, bonds, com-
modities and real estate. An example of
a hedge fund is the Bridgewater Pure Al-
pha fund, part of Bridgewater Associates,
which made $35.8bn of profit between
1975 and the start of 2012, making it the
most successful hedge fund in the world.
One recent example is The Children’s
Investment Fund (TCI), a British hedge
fund, which became the biggest share-
holder in the recently privatized Royal
Mail, in October 2013.
Although hedge funds can diƒer
greatly, they usually have similar key
characteristics. Firstly, as I have already
mentioned, a hedge fund’s investment
universe is only limited by what the fund
manager decides to invest in. Secondly,
hedge funds are only open to investors
that have a certain net worth that ex-
ceeds the required amount needed to be
able to invest in them. Hedge fund man-
agers in the US are legally required to ask
you if you have the money, as the SEC,
responsible for protecting individual in-
vestors in the US, do not scrutinise hedge
funds. This means that, due to the funds’
risky investing strategies, there may be a
high chance that you lose some, if not all,
of the money that you invested into the
fund. Thirdly, hedge funds often use bor-
rowed money, known as leverage, to am-
plify their returns. However, this is also
a risky strategy as losses are magnified if
the returns from the asset are less than
the costs of borrowing.
Finally, the fee structure of a hedge
fund is slightly diƒerent to other types of
funds. A common fee structure is known
as “Two and Twenty”, which means that
not only does the fund manager take an
asset management fee, usually 2%, he
also takes a cut of the profits made by the
fund, usually 20%. This is diƒerent to
other funds, which generally only have a
management fee.
Estimates say that over $1tn is man-
aged by the thousands of hedge funds
active in the world today. Hedge funds
can pursue many diƒerent types of strat-
egies, including macro or equity strate-
gies, amongst many others. Macro hedge
funds invest in stocks, bonds and curren-
cies with the aim of making a profit from
macroeconomic variables, such as coun-
tries’ economic policies or interest rates.
An equity hedge fund, which may be
global or country specific, invests in at-
tractive stocks, or hedges against down-
turns in equity markets, which means
that an investment is made to prevent a
potentially risky or uncontrollable sit-
uation. An example of hedging is buying
gold as a “hedge” against the eƒects of
inflation on the US Dollar, which means
that an investor will buy gold in order to
prevent inflation from reducing the pur-
chasing power of the US dollar, as infla-
HEDGE FUNDS
What they are, how they work and their impact on the global economy
REGULATING INDUSTRY The headquarters of the U.S. SEC is pictured above
Photo courtesy of Wikimedia Commons